What Are Some Key Features to Consider When Setting Up a Trust / Irrevocable Trusts?
Estate planning is important for anyone who wants to be certain of how their assets will be distributed and managed upon their passing — and trusts are one of its key elements. But what are the features of a revocable versus an irrevocable trust? And when should you opt for the latter? We’ll explore the matter in-depth right here.
Revocable Trust: An Overview
Also referred to as a “living trust”, a revocable trust is just what it sounds like — a trust that contains easily changeable terms. In contrast, an irrevocable trust can’t be modified after its creation without the consent of all beneficiaries.
But you might be wondering — what is a trust in the first place? Essentially, it’s a legal entity that an individual sets up to manage their various assets. And they set them up during their lifetime to make sure their assets will continue being used in a way that they deem appropriate — though, as you’ll see below, there are other reasons as well.
When the trust is formed and the assets are placed inside it, they are managed by a trustee — a third party. They’re the ones who make decisions on how the assets will be invested, and more importantly, how they’ll be distributed once the trust owner dies. Of course, the trustee must still follow the guidelines set by the trust owner back when the trust was formed — which is the entire point.
So, who uses trusts? Most commonly, wealthy individuals use trusts as a more preferable option to a will in the process of estate planning and stipulation of how their wealth is distributed and used upon their death. Apart from that, trusts can also be used to reduce tax burdens and stop assets from going to probate.
However, everything we’ve said so far stands for revocable trusts — but what are irrevocable trusts?
Irrevocable Trusts 101
Much like their revocable counterpart, an irrevocable trust can be used to avoid the costly and often time-consuming probate process — allowing you to set up arrangements in case of incapacity ahead of time, and keep your financials private in general.
However, irrevocable trusts have some additional perks, such as asset protection and estate reduction. These benefits are often compelling enough to outweigh their more tasking requirements — such as giving up control over your assets and becoming familiar with more complex strategies for managing your financials.
As we’ve said above — once the trust owner creates a trust, an irrevocable trust can’t be revoked or changed. There are exceptions to this, but there’s no workaround for the fact that all trust beneficiaries must agree to any changes before they’re made, barring something more serious like a court decree.
When a third party that will act as a trustee is designated, the trust owner — also called “grantor” in this case — transfers their assets into this new trust. When that happens, the grantor relinquishes their ownership rights, ceding control to the designated trustee. Also, the assets are no longer a part of the grantor’s taxable estate
When Do I Need an Irrevocable Trust?
Just like most other legitimate financial decisions, an irrevocable trust is neither good nor bad under its own merits — it can be both a great and a terrible decision, depending on who you choose as your trustee and whether you need this type of trust in the first place.
And that’s one of the most important things to determine — do you need this kind of trust in the first place? Let’s take a look at when people generally opt for an irrevocable trust.
Shielding From Estate Taxes
Most wealthy individuals who opt for an irrevocable trust do so because their substantial assets are probably subject to estate tax — which they naturally want to minimise or avoid entirely. In 2022, the tax exemption for estate taxes is around $24 million for estates of married couples or $12 million when it comes to individuals. And all estates that go above these limits are subject to federal estate taxation of up to 40% — though the taxes depend on your location, seeing as there are states that also levy additional estate taxes at their level.
Considering how high the exemption limit is, there’s only a small group of people that ever worry about it. However, it could become lower over time due to inflation — which is also something people keep in mind while planning for their future.
And when you do exceed the limit, there are plenty of strategies to consider — such as credit shelter trusts that let married couples leave substantial assets to their children and spouse without dealing with estate taxes. There are all kinds of combinations, including generation-skipping trusts that help shield your children from paying estate tax as well. And spendthrift trusts are there to help manage heirs that are notorious for irresponsible money habits — as well as special needs trusts for people who require help due to disability.
Protection From Creditors
Remember how irrevocable trusts help circumvent estate taxes due to the simple fact that the trust assets aren’t a part of the grantor’s estate anymore? Well, irrevocable trusts can be used to achieve the same effect with creditors.
And for people in professions that are at more risk of being sued — such as doctors, attorneys, and real estate developers — irrevocable trusts can be a way to keep the most valuable personal assets out of any potential creditors’ reach.
This is what asset protection trusts are for and they come in two varieties: domestic and off-shore. Though, bear in mind that foreign asset protection trusts are often a costly affair, and some states prohibit domestic asset protection trusts. Also, if a court concludes that you’ve created an asset protection trust with the sole intention of defrauding creditors, there are significant legal consequences — including being forced to undo the asset transfer to the trust.
Understanding The Complexities
Regardless of why you need an irrevocable trust, you will have to become comfortable with one thing — you’re definitely giving up control and ownership rights over your assets. And considering you’ve likely spent a lifetime amassing them, it’s not always easy; especially since you can only do so when you’re certain you have people you can trust.
However, if you have trustees that are — all pun intended — trustworthy, irrevocable trusts are an excellent way to protect your wealth and minimise tax exposure. And if you need help with setting up your revocable or irrevocable trust and understanding the myriad complexities of the process, don’t worry — you can hire experts that will manage the entire process and be with you every step of the way.
We’ll help you understand all the details and resulting implications of your estate planning actions, so you don’t inadvertently end up doing something you didn’t want in the first place. And we’ll help you deci